ResearchPaper

UnravelingtheTakeoverCode
By SagarShah (09BSHYD0714) May2010

JMFinancialConsultantsPrivateLimited

Abstract
Any acquisition, takeover or change in control of a listed Indian company attracts the provision of SEBIs Substantial Acquisition of Shares and Takeovers, Regulations 1997. Takeover Code has been amended several times since inception, still they havent been inline with the need of the hour. The paper has tried to analyse various critics of Takeover Code have tried to recommend amendments to the Takeover Code. Vast number of amendments needs review and be amended. This paper argues the complexity that the trigger points for acquisition of shares and tender offer introduced over the years lacks philosophy, and many other regulations can be amended. A very simple structure needs to be introduced making compliance of the regulations straight forward and easy to comprehend by management of these listed companies. With Takeover Regulatory Advisory Committee (TRAC) reviewing the amendments to be made to the existing regulations, the paper provides recommendations to trigger points to keep up the pace the ever changing economic conditions. The paper discusses various areas where an amendment is required and recommendations for same have been provided. Chief amongst these are the provisions relating to acquisition of shares, minimum open offer size, creeping acquisition limits, inter-se transfer amongst promoters, the chain principle and disclosure requirements. The recommendations are provided after comparing the Takeover regulations with UK and Singapore.

Introduction
Numerous listed companies were off their highs and were trading at attractive valuations during the recent financial crisis. During these times promoters and acquirers try to increase their stake or gain control in their listed companies. These times are also used by competitors or companies scouting for good acquisition targets as valuations are very attractive. Any acquisition, takeover or change in control of a listed Indian company attracts the provision of SEBIs Substantial Acquisition of Shares and Takeovers, Regulations 1997 (Takeover Code /Takeover Regulations). Indian M&A is coming out of its age and time has now come for review of Takeover Code. A lot of interpretation has taken place in the last ten years by SEBI, the takeover panel and the courts. Also, the economic condition has changed drastically in the past decade. First and foremost just a composition of corporate India in 1997 or around that period when the Code was originally formed and today it is completely different. The levels of promoter holdings now are vastly different, their aspirations and their financing needs are different. Also, there has been emergence of new asset class like private equity and when the law was originally written, it did not have things like private equity in mind and private equity today is very valuable source of capital for Indian market today. SEBI has set-up Takeover Regulatory Advisory Committee (TRAC) in September 2009 to look into changes that can be amended in the existing Takeover Code. The significant amendments required are pertaining to issues like share acquisition triggers, minimum open offer size, creeping acquisition, inter-se transfer between promoters, indirect acquisition (the chain principle) and disclosures.

Share acquisition triggers

The current level of threshold are 15% and 55% where if an acquirer breaches these levels then they are suppose to make an open offer. But the argument is whether this number should be 15% and 55% or something else? Should we make it in line with UK and other laws where the level for threshold ranges from 30% to 35%1? The TRAC does need to review these threshold levels very carefully and amend them. Lot of Takeover activities are dependent on these threshold levels. There actually has been no precedent behind the 15% threshold. It was agreed by P. N. Bhagawati Committee in 1996 when they reviewed the Takeover Regulations of 1994, where they agreed to retain the 10% threshold. Post that the number was amended to 15% and has been constant. 15% was agreed upon particularly in the context of promoter holdings in India being very low at that point of time. Tata and Birla Group have had very low holdings in the past and high teens, low twenties and that stood as good level of control then2. The reason why 15% should change today would be two fold. First the linkage between the concept of substantial acquisition of shares and control should be established. The manner in which the SEBI act itself postulates that it requires a regulation for two things; one substantial acquisition of shares and takeovers or which would mean control. The association between these two is unclear. Ordinarily one would never believe that 15% you can control a company but its because of the social and the economic setting of India including the kind of examples mentioned above that historically companies have been able to manage at that level. Second 15% does not hold good today, in many of the companies even the Tata Group is now largely in the 25-30% category. Earlier the old code was written more to protect the minority but in 2009 and 2010 and going forward, we will have to look at all the constituents of the market. We will have to look at the majority, the minority, the promoters and other investors as well. It is only when we find the right balance between all these three that we will have an efficient market. Thus, should the number be 30% going with global precedent or there should be some other number?

1 2

As per The City Code on Takeovers and Mergers - UK Interpreted from P. N. Bhagawati Committee report submitted in 1996

Recommendation The trigger for share acquisition and control should be dealt in a different way. The triggers should be dealt in accordance with the Companies Act, 1956 where any kind of transfer of share or control should be the threshold for the trigger and the investors should be given an opportunity to exit. According to Companies Act, 1956, to pass a special resolution of a company requires a minimum of 75% of the shareholders consent. Thus, when an acquirer acquires more than 25% control he can block the special resolution. Now this is a threat to investors and therefore they should be given an option to exit. So the threshold of acquisition of share or control of 15% should be raised to 25% + 1 share to trigger the takeover code. Another threshold of 55% makes no real sense. It can be reduced to acquisition of share or control of 50% + 1 share where the acquirer/promoter can control the management as they have the right to the entire board. At this level, he can appoint the management of the company and can also sell an undertaking of the company. Thus here the investors should be given a right to exit as it assumes lot of threats in terms of the structure of the company. Now coming to acquisition of shares, we can have more stringent disclosure rules as prevailing in UK which are discussed in later part of this paper. The acquisition of shares not necessarily assumes acquisition of control. Though in India it is observed where an acquirer acquires shares he generally demands control too. Thus considering the climate in India, we can do with the same thresholds of 25% + 1 share and 50% +1 share for acquisition of shares also. In case of private equity investments it is observed that they are not interested in control and do not intend to run the company. They just want stakes in the company and enjoy profits. But still they would not want the existing management to take decisions which are not acceptable to them and so they demand veto rights which gives power to stop changes, but not to adopt them. The influence that the veto conveys to its holder is therefore directly proportional to the holder's conservatism. Thus, veto rights also assume some sort of control and thus we can retain the levels of 25% + 1 share and 50% + 1 share in India in the near future.

Minimum Open Offer Size

When an acquirer acquires 15% and triggers the Takeover Code they are suppose to make an open offer for 20% of outstanding shares. Now when we calculate, post Open Offer the acquirer has total shares and control of 35% (15% by share acquisition + 20% in an Open Offer). Also, on trigger of 55% the acquirer is suppose to make another Open Offer of 20% which takes acquirer to 75% and post that if as per delisting rules if you are required to maintain minimum shareholding of 25% in public the acquirer cannot acquire any further shares unless he intends to de-list the company. Also, if we were to compare the same with UK and Singapore here is no concept of minimum requirement of open offer in in these countries as against in India we are suppose to make an Open Offer for 20% of the outstanding shares on trigger of Takeover Code. Thus, this needs to be reviewed and can be amended to match international standards. Recommendations In the current scenario when the acquirer acquires 35% control post trigger of 15% it does make a significant difference as he now can block special resolution and thus it doesnot seem attractive for promoters going beyond 25% + 1 share. In case when acquirer triggers 55% the entire balance shareholders should be given right to exit. Thus, the acquirer should make an Open Offer for the entire 100% of shares and allow him to de-list the company if he wishes. Also, it sounds acceptable because if an acquirer has acquired majority control he would be willing to acquire the rest of the capital provided he has financing arrangements in place. So the limit of mandatory Open Offer post threshold of 55% share should be for entire outstanding shares which will protect both minority and promoters interest. Beyond this if we were to take the above scenario for triggers at 25% + 1 share we can retain 20% Open Offer trigger and at 50% + 1 share we can have Open Offer for 100% of the outstanding shares and provide complete exit for shareholders and this level the Open Offer would make much more sense as that is one important threshold for control of management than the current level of 55%. Even though these regulations would not be as tough as the one in UK and Singapore where the acquirer on trigger of Code is suppose to make complete financial arrangement to purchase 100% of outstanding shares, it will be more beneficial to Indian economy and also protect interest of all classes of shareholders.

Creeping Acquisition
Under the current Takeover Regulations, acquisition of more than 5% of shares or voting rights in any financial year when the acquirer holds 15% or more but less than 55% of the shares or voting rights of the company concerned would also trigger the compulsory tender offer according to Regulation 11(1) and exemption in acquisition of shares or control upto 5%, where the acquirer already owns or controls between 55 to 75%, if the same is the result of buy back of shares by the company or purchases are made through open market purchases as per Regulation 11(2) second proviso. This exemption is subject to an upper holding limit of 75% in case of all companies irrespective of minimum public shareholding requirement under the listing agreement. Acquisition of even a single shares or voting right where holding is already 55% or beyond the exemption above would trigger the tender offer according to Regulation 11(2). Where a person already holds 60% and acquires further shares, and makes a tender offer which is fully subscribed (i.e. 20%), the acquirer would be holding 80 % post open offer. In such a case, if the acquirer is breaching the listing agreement which imposes a condition of public shareholding of a minimum of 25%, the acquirer must bring down his holding within a time period permitted by the exchange to be again in compliance with its agreement. In the same facts where the listing agreement only requires a minimum 10% public shareholding, the acquirer can continue to hold the 80% shareholding. In another fact scenario of a company with a listing agreement for a minimum of 10% public shareholding, where a person is already in control of 76% voting equity, acquires further voting rights, and the tender offer for 20% takes his holding to 96%, he must again divest his voting rights to below 90% levels within a period prescribed by the exchange. Recommendations UK Takeover regulations have creeping acquisition limit of 1% every 12 months and Singapore has 1% every 6 months i.e. effectively 2% every 12 months. In Indian the current regulations w.r.t. creeping acquisition provide enough opportunity for the promoters of the company and helps them protect the interest of shareholders. Thus, the current triggers are in line with the current economic scenario in India. If we were to amend as per 25% + 1 share and 50% + 1 share then we could have creeping acquisition limits as per the Singapore Takeover Code which allows creeping acquisition of 1% every 6 months i.e. 2% in 12 months. Above 50% + 1 share we can delete creeping acquisition trigger upto 75% shares where the promoter has right to pass special resolution.

Inter-se transfer between promoters

Inter-se transfers of shares are currently exempted from triggering Open Offer. Inter-se transfer means transfer of shares within the promoter group which includes group companies, relatives and promoters. There may not be any cause for concern in respect of inter-se transfers amongst group and relatives as the control continues to remain with the group. However, the issue assumes significance when it involves inter-se transfers amongst promoter groups such as between a foreign collaborator and an Indian promoter or between two groups of Indian promoters. In such cases, there is bound to be perceptible change in control. These are generally practiced to facilitate entry and exit of strategic partners, group restructuring etc. Quite often the foreign collaborators enter and remain with the company till such time that technology transfer is complete and may want to exit when their presence is no longer felt necessary. A minimum holding of 5% for 3 years period has also been prescribed under the Regulations in order to avail exemption in respect of acquisitions through inter-se transfers amongst two groups of promoters. In the absence of any precise definition of the word group, the definition as given in the MRTP Act is adopted in the current version of the Takeover Code, but the definition has widened the scope of exemption and has also led to interpretation problems. Recommendations Over the years a number of companies have taken advantage of this clause to restructure the business and exit under this regulation is generally at a higher price. In a study conducted under P. N. Bhagawati Committee review in 2002 it was noted that approximately 46% cases of inter-se transfers were at a price higher than market price, which benefited the shareholders with substantial holding. Thus, the exemption pertaining to inter-se transfers should continue. As far as the interpretation of group is concerned we have observed them in cases under Informal Guidance Scheme where most of the queries are pertaining to the interpretation of group and seeking exemption under them. Also, India is growing very fast and corporate restructuring remains to be the significant element in the current scenario where there is constant consolidation of shares. Thus, to have a better regulatory regime the Regulation must define its own scope of definition of group and define it under Regulation 2 which will give a better clarity.

Disclosure requirements
Disclosure is one of the most critical aspect whereby the minority interest can be protected. Disclosures increase transparency in the dealings of the acquirer apart from providing a warning system to the existing management of the target company. Thus, there should be transparent and purposeful dissemination of information. Regulation 7 - Acquisition of 5 per cent and more shares or voting rights of a company any acquirer, who acquires shares or voting rights which would entitle him to more than 5%, 10%, 14%, 54% and 74% shares or voting rights in a company, in any manner whatsoever, shall disclose at every stage the aggregate of his shareholding or voting rights in that company to the company and to the stock exchanges where shares of the target company are listed. Recommendations Disclosure practices in India are quiet stringent and tries to protect minority interest to a great extent. But if we were to compare the disclosure practices prevalent in UK our practices are liberal. In UK once the acquirer acquires initial 3% shares he is suppose to disclose it to the company. Apart from that any further acquisition or sale of 1% shares the acquirer is suppose to make disclosure. Thus there is a constant check on the acquirer acquiring the company and thereby tries to alert management of the company. If we were to compare with the USA where disclosures are given maximum importance, under The Williams Act the acquirer is suppose to make a disclosure at 5% and 10% levels. At 10% levels the acquirer is asked his intention for purchasing the shares. In India we can adopt USA standards and make stringent disclosures at 15% level where the acquirer is suppose to disclose intention of the purchase, complete funding, etc. This would make things more transparent and thereby protect interest of all. Also, at important levels like 10%, 14%, 24%, 50% and 74% shares or voting rights the acquirers should make a disclosure and the regulations should be applicable for sale of shares too.

Other Recommendations
The scope of applicability of the Takeover Code should be widened. Currently, it is only applicable to listed companies. It can be further extended to unlisted public companies, companies having shareholders more than 50, companies having net tangible assets of more than US$ 5 billion and so on which is much in line with Singapore Takeover Code.

Conclusion Need for re-look at the Takeover Code

With TRAC reviewing the Takeover Code the landscape of mergers and acquisitions is expected to undergo a major change and level the field for both retail investors and potential acquirers. Indian Takeover Code on the face of it currently, is very acquirer friendly, but the reality seems to be other way round. For an acquisition there are number of things responsible, the regulatory regime, the economic conditions, at times the structures are not acceptable to the board, financing is not available and then a number of our foreign investment laws until recently would have come in the way, the foreign acquirer would have to go through the FIPB approvals, so there are a lot of other extraneous hurdles preventing a healthy M&A climate. Also, there are illogical milestones along the way like 15% and 55% which needs a review. The weird thing is that in our Takeover Code, only two milestones which are relevant for control under the company law which is 26% and 51% is not even covered. On one hand we have companies act acting as base talks of 26 and 51% and the Takeover Code doesnt even mention them leading to a huge divergence among them. India has to find a right balanced regulations which benefits to all the class of investor categories. Trigger levels, Open Offer, disclosures, etc. all need a brief review and should be amended with proper precedents. TRAC should try to bring much more clarity in terms of interpretation of the Takeover Code and should try to offer highest protection to the interest of the retail investors who are the usual suspects in the takeover battles. Even as deal-making should be encouraged, the regulations should look at offering retail investors exit options beyond the scope of mandatory offers, and ensuring that they are rewarded on par with the exiting promoters. At the end the revised Code should be conducive for growth. It should facilitate healthy M&A and help Indian companies to achieve economies of scale and scope. On the whole to have a better and efficient corporate regulatory regime we must make amendments from time to time and keep up with global standards.